Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services.

Does Kroger Co.’s $500 Million Stock Buyback Make Sense?

The grocer is generating plenty of cash, but likely won't spend much of it on its stock this year.

Fresh off a strong start to its fiscal year, Kroger(NYSE:KR) just announced plans to give its shareholders a raise. Last week the grocery chain boosted its dividend by 14% to $0.21 per share. Management at the same time approved a new $500 million stock buyback plan.

Investors shouldn't look at that half-billion dollar authorization as a short-term target, though. Kroger's stock buybacks are a small piece of its overall capital allocation plans. And they are taking a back seat to other goals such as debt management and increased business investments.

Where the cash goesKroger's operations throw off billions of dollars that the company sends back to shareholders, after meeting its growth investments. Take last year for example, when it booked $4.1 billion of operating cash flow. That total was lifted by $0.6 million of new debt, bringing overall cash flow to $4.7 billion. The biggest portion of that cash went to the business: Kroger invested $3 billion in capital improvements. And the remaining money was divided between dividend payments and stock buybacks, with a heavy bias toward share repurchases. Kroger spent $1.3 billion on its stock last year and just $340 million on dividends.

That trend is holding so far this year. Kroger generated $1.8 billion of cash flow in the first quarter, which management directed mostly toward capital improvements ($900 million) followed by share repurchases ($585 million) while dividends ($91 million) were a distant third place. However, there are a few reasons to believe that share repurchases will slow down in the coming quarters.

Changing prioritiesFor one, Kroger told investors that they shouldn't expect much more in the way of buybacks this year. "It is not expected that any purchases will be made under this new plan for the remainder of fiscal 2015," the company said in a press release. Management isn't bound to that statement, but it does show that repurchases aren't a big priority right now.

Instead, Kroger is planning to increase its business investments significantly, which will take cash away from other priorities. The company is targeting spending $3.3 billion (up 10% from last year) on capital improvements like store upgrades and a national online shopping initiative. Kroger could also spend as much as $4 billion on price cuts this year to keep the market share pressure on rivals like Wal-Mart and Whole Foods.

Source: Kroger.

Finally, Kroger is likely hunting for more expensive acquisition targets. It had to take on a huge chunk of debt to fund its $2 billion purchase of Harris Teeter in 2013. And Kroger only recently succeed in bringing the debt level back down to its long-term goal. So now that finances are steady again, the company might snap up regional grocers that can help it jump into new areas. "If it's the right set of assets with the right growth opportunity like Harris Teeter was -- with all the new markets, I don't think we would be precluded from continuing to participate in industry consolidation," Chief Financial Officer Mike Schlotman said in a conference call last fall.

But if management does decide to spend cash on its own stock, they'll be getting a pretty good deal. Yes, the stock is up over 250% in the last five years. But earnings have improved dramatically over that time. Kroger's profit was $1.74 per share in 2010 but should be as much as $3.90 per share this year. So with the stock valuation at less than 19 times 2015's profit, share repurchases wouldn't be a terrible use of Kroger's growing cash pile.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool’s board of directors. Demitrios Kalogeropoulos owns shares of Whole Foods Market. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.